Some Bond Math

The Newfound Research Blog posted a great commentary on the current state of the U.S. Treasury market, showing with simple math why the strong gains being posted in the bond market this year are really being taken from future returns. They also point out the limitation of bonds to provide real protection should we face another financial crisis. From the post:

The bigger problem here is that without 10-year rates retreating to higher levels (implying bond values fall), or without 10-year UST rates going negative, the most 10-year bonds can rally in value from this point is 15.3%.

From October 9, 2007 to March 9, 2009 the SPDR S&P 500 ETF (SPY) returned -55.19%. The iShares 7-10 Year U.S. Treasury ETF (IEF) returned 20.15%. A traditional 60/40 portfolio would have returned -25.05%. If a similar crisis were to occur today, 10-year rates would have to fall below 0% to offer similar protection.

That’s pretty stark math for those hoping their traditional 60/40 blend will offer substantial protection in a market correction. In addition, with 10-year Treasury rates at 1.55% (as of 7/19/16), there is very little expected return for what seems like quite a bit of asymmetric risk. This, of course, assumes that that yields are not heading for sub-zero land, an assumption I used to be much more comfortable making…